Abstract
We develop and estimate a dynamic game of strategic firm expansion and contraction decisions to study the role of firm size in future profitability and market dominance. Modeling firm size is important because retail chain dynamics are more richly driven by expansion and contraction than de novo entry or permanent exit. Additionally, anticipated size spillovers may influence the strategies of forward-looking firms, making it difficult to analyze the effects of size without explicitly accounting for these in the expectations and, hence, decisions of firms. Expansion may also be profitable for some firms while detrimental for others. Thus, we explicitly model and allow for heterogeneity in the dynamic link between firm size and profits as well as potential for persistent brand effects through firm-specific unobservable factors. As a methodological contribution, we surmount the hurdle of estimating the model by extending a two-step procedure that circumvents solving the game. The first stage combines semiparametric conditional choice probability estimation with a particle filter to eliminate the serially correlated unobservable components. The second stage uses a forward simulation approach to estimate the payoff parameters. Data on Canadian hamburger chains from their inception in 1970 to 2005 provide evidence of firm-specific heterogeneity in brand effects, size spillovers, and persistence in profitability. This heterogeneous dynamic linkage shows how McDonald’s becomes dominant and other chains falter as they evolve, thus affecting market structure and industry concentration. The online appendix is available at https://doi.org/10.1287/mnsc.2017.2814 . This paper was accepted by J. Miguel Villas-Boas, marketing.
Highlights
The strategic decision of a firm to expand or contract is inherently dynamic with long term implications for its market outcomes and those of its rivals and, industry structure and evolution
Our paper presents a new empirical model of retail chain dynamics that allows for endogenous firm size, heterogeneous effects of size on future profitability, and the consequences for market dominance and evolution
Through a firm specific unobservable the model accounts for a heterogeneous dynamic link between firm size and profitability, that may arise from inter-temporal size spillovers and persistence in profitability
Summary
The strategic decision of a firm to expand or contract is inherently dynamic with long term implications for its market outcomes and those of its rivals and, industry structure and evolution. We develop and estimate a dynamic game of strategic firm expansion and contraction decisions to study the role of firm size on future profitability and, market dominance and structure. The anticipated effects of firm size on future profitability, i.e., size spillovers, may influence the strategies of forward looking firms. This may in turn affect the evolution of market structure. Firms may “over-expand” in periods when they expect positive spillovers (e.g., Shen and Villas-Boas 2010). These spillovers may not even be realized but would still affect industry evolution.
Sign-in/Register to view highlights & summary Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
